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​Bernard Hickey fingers the electricity and local government sectors as the inflation culprits underneath our painfully high interest rates and currency. He suggest the Reserve Bank reads them the riot act

The inflation culprits: the electricity industry, local government rates, government charges

By Bernard Hickey

New Zealand's inflation rate has been significantly higher than it should have been for the last decade because two major semi-regulated and mostly publicly-owned sectors raised their prices by around 5% to 8% each year for that decade.

Local Governments and electricity companies are those culprits.

They have become the silent killers of our manufacturing export sector and our tourism sector.

Their persistent inflation has acted like a type of plaque in the arteries of the economy, putting up it's 'blood pressure' of inflation, interest rates and the exchange rate.

Without that persistent inflation at two and three times the rate of inflation in the rest of the economy, New Zealand's interest rates and its currency would no doubt have been significantly lower.

I've always wondered why the Reserve Bank Governors Graeme Wheeler and Alan Bollard haven't at some point in the last 10 years convened a conference of mayors, council CEOs, electricity generator-retailer CEOs and lines companies CEOs to read them the riot act.

These mayors and CEOs have no doubt acted in good faith and had plenty of good reasons to increase those prices. They believed they were doing the right thing in the long term for their shareholders, ratepayers and customers.

They argued they needed to increase those rates and electricity prices to justify investing in infrastructure that had been under-invested in through the 1980s and 1990s.

Councils said they had extra responsibilities under the 'four well beings' policy of the 2002 Local Government Act to improve the social, economic, environmental, and cultural well being of their communities.

Electricity generators, lines companies and Transpower argued they needed to lift prices to pay for extra generation and more reliable networks to ensure the five week-long power shutdown central Auckland endured in 1998 never happened again. These were all laudable aims.

It's debate-able whether the extra charges have worked to produce the commensurate extra value of all those council services and reliable power networks, but there were consequences and I would argue they were much worse than the benefits gained.

These two uncompetitive sectors imposed a massive price on the tradable sectors of the economy - exporters and those competing with imports.

The Reserve Bank's hard-wired focus on keeping inflation between 1% and 3% meant it had no choice but to react with higher interest rates that helped make the New Zealand dollar between 10% and 25% over-valued relative to commodity prices and our current account deficit.

This crunched the size of New Zealand's tourism sector down from almost 10% of GDP in the early 2000s to around 8% now.

In response, and unlike the local government and electricity sectors, these tradable parts of the economy rolled up their sleeves and whittled down their costs.

They came up with innovative ways to use technology and have improved their productivity because they had do.

It need not have been like this.

In any area where there is no competition, the regulators and policy-makers should be hard at work keeping the pressure on to improve productivity and ensure the price-setters don't take the easy path of just increasing prices to solve any problem.

Until recently, Local Government fees and charges were essentially unregulated. In theory, the electricity industry is regulated by the Commerce Commission, but its mandate was to ensure generators and lines companies didn't make too much money and ran reliable networks.

There appeared no mandate to keep price inflation under control.

The best example of where regulation did work to bear down on prices was telecommunications.

Repeated and persistent interventions to ensure number portability, the breaking up of Telecom and the encouragement of mobile competition all helped keep inflation low and actually create deflation since 2011.

The Reserve Bank refers to this structural fall in telecommunications costs as the '2 Degrees effect' and it helped keep interest rates low since 2008.

If only the Reserve Bank could encourage regulators, politicians, ratepayers and voters to intervene as effectively with local governments and electricity companies to create many more such '2 Degrees effects' then New Zealand might not have the structurally inbuilt high currency and interest rates that are so damaging to the real economy.

A summit might do the trick, if only to shame these two culprits into acknowledging the pain they have caused consumers and producers alike.

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A version of this article was first published in the Herald on Sunday. It is here with permission.

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While I agree, I think its also more damaging in that the areas not being sectors not being spent in are deflationary, bad news. Retail seems to have suffered, eased by a high exchange rate, taht wont last, then really bad.
regards

I'm doing it myself, as I get charged more by councils I just hack away somewhere else. I just got charged an extra $2500 to put telemetery on my bore, plus $500 to check its working properly. Now I just need to find something to cut, insurance could be it or perhaps labour.
There will be no winners.

slowing the real economy down is inflationary as it reduces purchasing power.
Industries like tourism find it hard to keep up with the level of reinvestment required to stay competitive in their industry. If they use borrowing to finance upgrades, especially for smaller operations (vs multinational hotel chains, for example) then that sucks more money out of their operation.

If people think "money being spent somewhere else" is a good thing, they can send me their paychecks and I'll spend it for them. As you say money isn't being spent somewhere else though, so where is it going? Well many councils have one arm tied behind their backs by central government agencies, demanding all sorts of complaince and regulation. That costs money off the council, and while it goes in wages, it doesn't produce value for the people paying the rates bill. that's why we're looking at things like mandatory minimum wage issues to patch the failure, but that will just suck more money off (paye, pie, gst, levies, cost recoveries for RMA etc) which goes away from tourism and other industries needing it, and creates inflation in wealthy areas, where the increase in propotion to the "wealth-cost" (ie inflate cost from living in wealthy areas and meeting wealthier levels of lifestyle) means the money is less effective than it would be spent at grassroots earning point. But the wealth-spenders create higher inflationary spending causing RBNZ to curtain everyone, further killing the golden goose.

the RBNZ mandate was set in a time where that level of population and wealth-cost wasn't expected.

North & South magazine this month highlights a 300% price increase of electricity from 1990 at 9.1c to 2013 at 27.4c average.
Also power price averages in the USA are 12.09c while NZ residential average of 28.2kwh. And we have Hydro dominant while USA burns coal etc.
NZ residential subsidises industry by one of the largest differentials.
So how does the highest interest rates in the developed world suppress these high electricity charges?

What this shows is NZ has a serious problem with institutional failure. Local government and the electricity industry are basic building blocks of NZ Inc. The fact that these areas are so out of control, transmitting inflated costs onto others shows there is something out of balance in NZ Inc.

Why is it that the our political and economic checks and balances have been unable to maintain a 'competitive tension' between the different sectors of our society?

Why is it that the neoliberal reforms that included the Max Bradford electricity reform have failed to deliver?

Why is it that the counter revolution including a new political system -MMP have failed to provide balance?

New Zealand has for 50 years been trying to find a political economic system to replace dependency on Britain. In 1965 50% of our exports went to Britain by 1975 only 10% went, nowadays on percentage terms it is virtually nothing. Adjusting to this change created Muldoonism, which failed. This created the revolutionary neoliberal Rogernomic reforms which failed. This led to the MMP era which also appears to be failing.

I think we have to look at the wider implications of what happens to people's thinking when we regulate.

The word regulation appears to conjure up images that the State has everything under control and hence the private person doesn't need to take action........as it is apparently being taken care of by the regulator!!

It is interesting that you mentioned Telecom Bernard......Telecom has been forced into a competitive position......when it was first removed from State control I would call this deregulated.......the pressure has been on Telecom ever since to compete with other providers..........This did not happen to electricity and has been one of the failures that every Politician should know about.

I'm guessing Bernard that you would want more regulation to solve the issue......but is it not less regulation and enforcing competition that removes price distortions?
Councils and Electricity have been State dominated and if you remove that domination which has been highly protected then you will obtain lower prices which are closer to the real costs in provisioning services.
The State owned electricity companies also had to return a shareholder profit back to the Government......the way the bookwork is undertaken to get the profit to provide the shareholder return leaves me with a sour taste........take a loook at our banks....massive profits to distribute to shareholders with not enough to run the show.....hence their constant borrowing.
Electricity is no different.....distribution of profits back to the shareholder Government with not enough left to run the show hence the prices had to increase for repairs, maintenance and any capital works etc......
The differences in bookwork is why SME's keep the country going.....

Notaneconomist I agree that competition is good. But this discussion is so distorted in NZ. Deregulation does not automatically lead to increased competition, neither does asset sales. Private monopolies, duopolies and cartels are just as bad as state ones. It would be interesting to plot construction material prices against electricity and local government prices. I would suggest it is not much better.

The solution is to get the right sort regulation in place. For the telecoms industry that was rules such as number portability.

I would suggest in NZ that poor performing state and private monopolies are being protected by a dysfunctional political system and a lazy overly policitised civil service.

Brendon.....we have a Commerce Commission and I have wondered on many occassions what actual use it is.

Is it regulation or is it the Commerce Commissions failure to do the task?
Anti-competitiive behaviour is a far bigger issue than regulation....there is a rather unusual mindset amongst Politicians and others that big is best.....but does big deliver and/or contribute proportionate to the size over say SME's???

The best thing that ever happened to Telecom was to split it up and allow other players in the field. I'm not one for having to many rules....but I do see a need for ensuring that no anti-competitive behaviour exists and I think we have an enormous failure in this area.....it is too easy for the old-tie brigade to play bully on pricing......and the consumer is the one bearing the load.

While I agree that this can happen Cowboy.........the biggest problem lies within another bureaucracy.......that of Statistics NZ and the compulsory requirement to supply information and data!!!
This information and data has the same effect as insider-trading !!!!

So KH......what do you think the Commerce Commissions role is......competition comes from ensuring anti-competitive behaviour doesn't exist!!! That is the only regulation (if you want to call it that) needed.
I wouldn't call it regulation......the commerce commission is like the referee, blowing the whistle, handing out the yellow and red cards.....and what have they been doing? Sweet fanny adams...which is pretty typical of any bureaucracy in NZ.

Everytime you have a business with mutliple arms within one industry you're going to have problems.......that 's why NZ'ers overpay for power, banking services, Council services, anything that comes from the likes of Fletchers and then there's the supermarkets.....we are far too small a country to allow these types of anti-competititve behaviours.

The only way that NZ'ers can claw back some of their overpaid rip-offs is too buy shares where they can to try and offset some of their annual usage.

If you're off-setting costs........you don't have to directly invest in the provider of the services you buy from. You also don't have to buy the shares in a NZ entity........covered call options can provide a good monthly income.

A few minutes effort at the Statistics NZ web site shows that civil construction prices have risen 50% faster than consumer prices over the last decade.(In case you haven't read any of my previous comments on this topic contracted out civil construction is where most of your rates go.)

So if anyone has any insight into why LG input costs have rocketed over this time and what the options are for mitigating the effects of those price rises I, for one, would be very interested to know.

Kumbel how much is the construction price increases due to genuine input increases -some due to the increase in oil prices but does it account for the whole increase in LG input costs? For instance why is concrete so expensive in NZ?

Is LG suffering from the same monopolies, duopolies and cartels that are inflicted on the rest of us?

If the answer is yes Kumbel then the solution is introducing the right sort of regulations that will bring competition into the construction material market.

On a related issue why is that our professional bodies aren't highlightly theses issues -engineers, lawyers.... Has this ticket clipping economic model spread to them too?

Partly real rises in commodities such as oil (which impacts the operating costs of machinery as well as the bitumen used to seal roads). Don't forget that making cement (or steel) is an energy intensive process so electricity price rises impact on these other inputs.

But mostly I think it is an unforeseen outcome of central government muddle.

Muddle #1 was more or less making it mandatory for councils to divest their works units and to contract out all physical works. It's been a gravy train for the contracting companies. For various reasons to do with risk management, Health n Safety etc councils aren't incentivised to pick the cheapest tender so basically eliminating the price competitive aspect of tendering work. And we have ended up with a small royalty of contracting firms with some rag tag little firms picking up the rats and mice work.

Muddle #2 has been a complete absence of co-ordination between central government and local government. Central government has imposed random requirements on councils to upgrade infrastructure as well as ramping up their own construction programmes without any thought to the impact this glut of work would have on civil contracting prices.

So, four engineering consulting firms, two national contracting firms, two building material suppliers, one cement supplier, maybe two steel suppliers - what do you think is goingto happen to prices?

#3 - the four well-beings (social, cultural, environmental, infrastructural, but especially the first two) gave a power of general competence to TLA's in 2002 for the first time ever. This coincided with a period of many graduates with soft degrees, rapidly rising house prices (with a wealth-effect which pervaded the economy) and aided and abetted by your #2, Central Gubmint devolution. This had five results.

There was a rapid rise in 'soft' spend such as events, festivals, and basically anything that fitted 'social/cultual'.

There was a rapid rise in TLA staff numbers, ostensibly to handle #2, but at least as much driven by pure empire-building and certainly by the social/cultural spend.

There was a rise in corporatisation within TLA's, with (e.g. CCC) whole layers of old, hard-hat manager types with real-world experience, being swept away and replaced by many more layers of credentialled desk-jockeys with PA's, KPI's and other - er - TLA's.

There was (remember this was a Labour decade) a very active movement towards the 'We Know Best' style of TLA attitude to its peasants I mean ratepayers - the antithesis of Customer Service. More Central Empires, less Local Community.

There was a lag effect in public/customer perception of all this - the revolution was not televised. So there was enough time for enough of it to take root, and permanently affect cost structures.

#4 - the economically clueless effects of RUB's, MUL's and DC's, which acted to ratchet up land (and, more slowly and more latterly, build) costs. As this effect (I've detailed it in all its gory glory here) 'enrichens' every existing householder, if thinly, and existing land-bankers, very directly and by a lot, all at the direct cost of FHB's, this has had it's own baleful set of domino effects:

Encourages (via the wealth-effect of constantly rising house/land valuations) the cashing-in of some of this unearned CG, and inevitably this flows more to economically low-value investments in consumption (holidays, cars, appliance upgrades etc) rather than to high-value (education, business formation)

Squeezes builders towards the high-end, high profit sector, as the effort in building a 300 squares mansion is not proportionately more than throwing togther an 80 square shack.

The coincidental Elven Safety mania, wherein every possible bystander must be protected against every conceivable hazard, has been enthusiasitically promoted by the TLA minions, as it is Power and allows the building of yet further Empires. Yet Mo' cost layers.

All of which progressively (or, actually, Regressively) locks out FHB's

The increase is largely driven by energy and material cost (which is mainly due to the former). Just look at the huge increases in bitumen price over the 2000-2010 period, the cost of building and the maintenance of roads has increased significantly over this time. Unfortunately 99% of the public are oblivious to these costs as they don't realize that as energy prices rise maintenance costs will increase. The same people then proceed to complain when LG raises the rates (as required to cover increased cost).

When the next round of oil price rises occur we can expect more of the same. Energy costs have a huge impact on all facets of life. This is one of the reasons why many were sceptical of your proposed 'smooth transition' to electric cars Brendon. Energy impacts everything; manufacturing, food production, mining, transport, heating etc. It's not going to be a simple problem to solve! And unfortunately, not all forms of energy are fungible.

Thanks Plutocracy I think oil supply is a concern. Maybe I don't have the same level of worry as you do but there is certainly some worrying developments. The oil price floor nowadays is about $100 a barrel whereas it wasn't that long ago when it was $20. AEP recently detailed the massive investment to search for new oil fields with pretty poor results.

Electricity wise I asked a friend today who is in the industry about the cost of productivity for new generation for NZ. He said wind and geothermal has a long flat plateau in front of it. Photovoltaic is currently more expensive but costs are declining fast.

So the oddity is that domestic energy sources have low and stable costs of production while imported energy costs are high and uncertain.

Yet across many sectors in NZ domestic prices that are not traded internationally have higher inflation compared to sectors with internationally traded goods.

This seems to indicate the problem is more to do with a lack of competition in NZ than it is about rising global energy prices (which would affect internationally traded goods too).

P.S I think you are overstating the case by saying I proposed a 'smooth transition' to electric cars. All I showed is some numbers indicating NZ has the capability to increase electricity production to power the equivalent of our current domestic vehicle fleet. I acknowledged there are other difficulties in the transition so it might not be 'smooth'.

Well from what you have written it appears you are honestly looking at this. In terms of electricity some countries are now looking at solar and wind as cheaper than fossil fuel production. Some of the traditional big profits have been for peak charging, solar and wind have gutted that pprofit in Germany and Queensland that should mean cheaper prices in the economy.
Atlernatives v fossil plants, of courrse its a dog chasing its own tail to an extent. Even as alternatives get cheaper, the energy to make them which is fossil fuel based drives up their input costs. Hence i wonder on how much cheaper they can get.
Im not sure Id agree that domestic energy sources are low, I'd say they are 30% + above where they should be if you look abroad as a comparison. Add in NZers earn less and thats a crippling effect on our economy IMHO, it needs to change. Sadly HC and whats his name didnt see it that way as a lot of the rises can be blamed on them. Which is strange considering its a regressive atx in effect. JK's Govn of course took it further....so much for reforms.
"rising global energy prices" lets seperate out oil which is priced the same world wide and domestic electricty. New oil fields are smaller, harder to find, often have difficult geology and are further from "civilisation" all this drives up its cost to extract. From what I can read future oil fields are looking at $120 a barrel so frankly I dont see that private companies will extract it as we cant afford to pay $150+ for it.
EV's cost more than people like you and I can pay and afford a big mortgage on an over-priced house, ego something has to get a lot cheaper.
Its going to be interesting to watch, to say the least, and of course we are in the test tube, not outside of it.
regards

well the councils used to do their own construction work, to their own standards. this vertical integration meant the only paid cost, and kept control of the regulations and compliance.

Now all that is put out to contract. Contractors have to have return and cover risk, and the councils are a pretty decent cash cow target for some jobs... the biggest area being regulation and compliance because being the council they're not allowed to complain about being expect to provide platinum quality on everything, and they are force to do mandatory scheduled work, rather than prioritise more sensibly.

Having spent 20 years in maintenance all I can say is "prioritise more sensibly" is absolute b*llocks, its short form for "run it til it falls apart but by then I'll have got a job elsewhere" management mentality.
eg I had one customer that didnt fix a leak on an absorption chiller plant and didnt keep it pressurised with nitrogen over winter to boot, didnt want to pay for the N2 or the man to go see if the bottle was empty. The result was a 20 year old plant with a life of 40+ lifespan turned into a 10 tonne rust bucket and had to be replaced, nice little earner that one. ie pay me to look after it, or pay me to replace it.
regards

Well they didn't "prioritise more sensibly"....did they????
If you have mandatory requirements to do something.......you can be throwing good money at something that doesn't need it........it all comes down to common sense and lack of accountability!!!!

If I am the management in my private business and I stuff up....I pay the cost of that stuff up....but if you are in the golden triangle of Government, bureaucracy or public service.....there is always coin regardless!!!

If we are to have equality then perhaps everyone should be accountable by the same method. It would get rid of the free-riders!!

Accountants "sensibly" decided to save the $s. They made redundant the engineers whose advice they didnt like.
"Common sense" frequently isnt, its used by lots of ppl who in reality are utterly clueless, hence why I detest the term so much.
Large private businesses are just as bad as Govn departments, if not more so actually.
"free riders" I often think and you conform it frequently, there is no humanity in extremism/fundimentalism. People are not machines, they all make mistakes, something that seems to be beyond your grasp/foregivness.
regards

“You're entitled to your own opinions, but you're not entitled to your own facts.” ~ Senator Daniel Patrick Moynahan

“The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with itself.” ~ Francis Bacon, (1561-1626)

“A lie can get halfway around the world before the truth can even get its boots on.” ~ Mark Twain

“Ignorance is a choice.” ~ Neriah Lothamer

“The greatest of faults, I should say, is to be conscious of none.” ~ Thomas Carlyle

It was leaking? Did he check it weekly?
Did head office demand he replace it with a larger current model to match "customers/ratepayers demands"?

There is a 1.5km stretch of road in the middle of this farm. It's a dead end, and sees around 6 cars a day in traffic. The council had it scheduled for routine re-sealing, so they re-sealed it. Nothing wrong with it but it was due to be done.

Likewise one council upgraded their water supply system, then under 3 years later the rules changed and they were forced to upgrade it. Nothing wrong with the old one, as it beat the old standards by a wide margin...but was just short on the new rules.

Yes the air was leaking in, absorption chillers have a very corrosive mixture inside them are made out of steel, and have lots of very small holes to spray the cooling fluid. Result a 20 tonne rusticle.http://en.wikipedia.org/wiki/Absorption_refrigerator
Accountants never check anything, and if they dont/wont pay to have it checked, it doesnt get checked, they decided to move to a break / fix contract froma PPM contract, it was saving them lots of $....
"Head office", see above.
Though I did do a $10million centralised CHP concept design for them with Gas fired CAT generators using the hot water to heat in summer and cool in winter.
regards

We used to have accountants enforcing preventitive maintainence programs. (in the theory that early repair prevent lost time and product)

Problem was "if it ain't broke, don't fix it" comes in to play. Many of the systems suffered more from maintenance staff making simple mistakes/not logging off properly, knocking or forgetting things than they ever did from beneficial neglect.

Likewise in several cases the maintenance requiorements were explained and the deal didn't get accepted - the paid someone else. That's why they ended up making everyone redundant from that small company. good product, but just no-one could justify the price.

PPM can be taken too far, and accountants vary from business being crippled due to lack of funds to utterly clueless and wasteful, but if you argue and the 1 in 1000 happens they'll sack you.
Me, I learned to not argue and take the hint to move on, a company run that badly isnt going to prosper and will look for scapegoats, best well clear of.
PPM has uses if the equipment is mission critical, as an example a clutch on a helicopter, so I think the manufacturer says it has a life of (say) 10000 hours and its replaced at 5000. A car on the other hand you typically run til it fails, though I have always changed them fully if saying rebuilding an engine.
regards

I run a risk/treat assessment similar to what we used to use in security work.

If it breaks? Or when it breaks?
What is the replacement cost? Downtime? Morale and inconvenience?

I also use a philosophy of resilience and modularity, from my time do computer field repairs. Try to use interchangable parts. Identity true work requirements from fad chasing, so that gear can be interchangable across tasks. Look for mission critical stuff (refrigeration is a classic, you can't just swap a unit in a out - they need to be bled, pressure checked, and not just by an operator - and down time means lost product and/or emergency relocation).

A tractor is critical... mine broke yesterday, rear swing arm (someone had replaced a 25mm pin with an 18mm bolt, so the top of the socket was stressed and deformed, and gear lever broke off).... but I have access to a second tractor.... so no big deal...once I towed it out of the race.

But motorbike chains are consumables, and the only part the wear is the cog; which is replaced at the time the chain is replaced anyway. So it's better to have a spare bike, than to PM the chain - much better use of time/money.

Then again, any Government that looks ahead beyond the election cycle could plan to replace those jobs by committing just a fraction of the Manpouri energy as an incentive to new energy demanding industry.

Um, no, we dont want energy intensive industry. We'll need that power to take us from 72% renewable higher inside a few years.
Jobs just wont go to such areas without huge tax payer subsidies IMHO. On top of that my experience down there is no one wants to go there, and those "stuck" down there get paid crap as they dont want to move. Ive een there seen that a few times (in different parts of teh world). Me Ive always been prepared to move and learned to move to spots with lots of employment choices.
regards

I too was a "prepared to move". Got to live in PN, Wgtn, Auck, Dunedin, Chch, Fdg, even NP for a short while. That's how I ended up "stuck down there" in Northern Wairarapa, because when the decisions came at head office level they cut staff at my branch and last on, first off. which, with a recent move, left me stranded.

Bernard, ye are a bit late coming to this party - many of us have been banging on here for years about price-gouging by statutory oligopolies (of which these are two). But to suggest the RB effectively take over their management is a bit silly: we may as well dispense with elections and parliament and hand government to Wheeler for life!
Ergophobia

Im not sure there is much of a constant/direct subsidy? The power is bought off Meridian and a dedicated plant, but Meridian would go no lower.
Profits? looking at Rio's returns they dont look very good at all.
regards

it is not just the areas that Bernard has identified. CAA is currently doing a round of consultation for a funding review, and it is structured to overlook a couple of obvious things.
Firstly a clear, underlying assumption in their approach is that the structure of the Department is the best that it can be and that it operates at it's most efficient. Something anyone in aviation will tell you is wrong.
Secondly, while the whole of NZ benefits from aviation, the CAA is attempting to recover it's funding from the aviation community, a comparatively small base. The impacts of it's performance to date has seen the closure of many small businesses including aeroclubs and engineering, with the resultant loss of jobs and therefore tax revenue for the Goverment, no to mention the added cost on the social policy departments etc.
Not convince that it would be any different under labour though

I reckon this is one of the unintended consequeces of the original Roger Douglas "User Pay" philosophy.
At first glance it seems like a form of natural justice... users pay for it...
BUT.... I think it became a licence for all these little regulatory bodies to become kingdoms and fiefdoms... where the primary concern is the organism itself.... I'm guessing that ALL of these regulatory bodies have grown dramatically since user pays came in.... and that the salaries of exectutives have gone up exponentially since user pays came in...
In a way ...user pays is kinda like a hidden tax..... because most of the user pays services are in regard to compliance to Govt regulations ...even thou it might be for the safety of betterment of the collective whole...